## Breaking Out of the Third World: India's Economic Imperative — Address by Stanley Fischer

_IMF News, January 22, 2002_

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## Bibliographic details
- Published: January 22, 2002

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### Introduction
- Context: Speech delivered at the India Today Conclave, New Delhi; as prepared for delivery, January 22, 2002.
- Global backdrop: world economy subdued after unexpected weakness and the events of September 11; cautious optimism as industrial production and financial markets show signs of stabilization.
- Core message: India must take decisive steps now to boost long-term growth and fulfill its economic potential; complacency must be avoided.

### Achievements and Key Statistics
- Economic growth averaged 6 percent a year in the 1990s, led by services and a dynamic IT industry.
- Poverty:
  - Fell from 55 percent of the population in 1974 to an estimated 26 percent in 2000.
  - During the nineties, the poverty rate is estimated to have fallen from 34 percent to 26 percent.
  - About 260 million Indians still live below the official poverty line.
- Social indicators (roughly last two decades):
  - Life expectancy: from 55 to 63 years.
  - Infant mortality rate: from 108 to 70 per thousand live births.
  - Literacy: rose from 45 to 68 percent for men and from 29 to 45 percent for women.
  - Current literacy levels: 68 percent for men and 45 percent for women; China: 91 percent for men and 76 percent for women.
- External position:
  - Official reserves now stand in excess of six months of goods and services imports.
  - Reserves are more than four times the level of short-term external debt.
  - External debt has declined to around 22 percent of GDP.
  - Current account deficit has been held to less than 1 percent of GDP in recent years.
- Investment and FDI:
  - FDI in India averaged ½% of GDP during the last decade; in China it was 5% of GDP.
  - Private investment in India around 15% of GDP; greater FDI could permit a nearly one-third increase in private investment relative to GDP.
- Fiscal position:
  - General government deficit nearly 10 percent of GDP.
  - General government debt risen to almost 65 percent of GDP.
- Growth objective:
  - Planning Commission estimate: it will take growth rates of 8-9 percent over the next decade to reduce the poverty rate to around 11 percent.
- Returns to education (World Bank (1995) review for Asia, cited):
  - Private and social returns: 39% for primary, 19% for secondary, and 20% for higher education.

### Achievements and Challenges — Analysis
- Driving force: ambitious reform program after the 1991 balance of payments crisis — industrial and trade liberalization, financial deregulation, improved supervision, privatization and FDI-friendly policies.
- Recent slowdown: growth has been slowing since 1997; attributed fundamentally to a slackening in the pace of reform (droughts, high energy prices, Gujarat earthquake noted as exogenous factors).
- Distribution of growth: services-led growth but industrial growth has slowed sharply; industrial growth needed to provide high-wage employment for the 70 percent of the labor force still working in agriculture.
- Policy slippages: weaker growth and policy slippages undermined fiscal position and prompted credit rating downgrades.

### Sustaining Stronger Growth — Policy Priorities and Recommendations
- Overview: Focus on five key areas — embracing globalization, structural reform in product and labor markets, education, strengthening the financial sector, and fiscal consolidation.

- Embracing Globalization
  - View: globalization should be embraced purposefully and cautiously; India should position itself to compete internationally.
  - Trade:
    - India has cut tariffs and removed quantitative restrictions, but tariffs remain very high by international standards and anti-dumping measures are frequently used.
    - Advisory Council suggestion: move average industrial tariff level from 34 percent then to the East Asian average of 12 per cent by 2005; the average tariff level in India had not fallen since the report but the 12 percent target remains sensible.
  - Capital account liberalization:
    - India's cautious approach limited contagion during the Asian crisis by containing short-term debt.
    - Benefits to greater openness, especially FDI, are emphasized: FDI transfers skills and technologies and has spillover benefits.
    - Capital account liberalization should proceed gradually but steadily as the financial system and fiscal policy are strengthened.

- Structural Reform (factor and product markets)
  - Industrial deregulation priorities:
    - Eliminate preferences for small-scale producers.
    - Further ease constraints on foreign direct investment.
    - Streamline regulatory procedures.
    - Revamp bankruptcy legislation.
  - Labor market reform:
    - Repeal legislation blocking layoffs in medium- and large-sized firms (as announced in Minister Sinha's last Budget speech).
    - Legislation to ease constraints on hiring contract labor.
  - Agricultural reform:
    - Abolish controls on prices, trade and movement of agricultural commodities.
    - Sharply reduce role of government procurement agencies and dereserve agricultural processing.
    - Current government food stocks represent a significant fiscal drain and exceed what is needed for food security.
  - Power sector reform:
    - Primarily state responsibility; central government can condition funding on reforms such as metering, energy audits, commercialization of distribution, and raising tariffs to economically sensible levels.

- Education
  - Emphasis: investment in education, training, and talent development is critical.
  - Literacy shortfalls highlighted relative to China.
  - The Prime Minister's Economic Advisory Council report details necessary measures; universal primary education is an effective anti-poverty measure.

- Financial Sector Strengthening
  - Lesson from Asian crises: importance of a strong, well-regulated financial sector with prudential and supervisory systems, strong governance, and mechanisms to resolve weak institutions.
  - Progress and remaining weaknesses:
    - Prudential norms tightened, bank capital bolstered, supervisory systems strengthened.
    - India undertook a Financial Sector Stability Assessment.
    - Remaining issues: stock market scandal (governance), problems with UTI, development finance institutions, urban cooperatives, weak banks, and high non-performing loans.
  - Privatization and ownership:
    - Government commitment to reduce ownership in financial sector is welcome and should be pursued.
    - Concern that private investors may avoid entry while government retains controlling shares; government control historically leads to deterioration of institutions.
  - Goal: strengthen supervision, governance, and resolution mechanisms to enable the financial system to finance investment.

- Fiscal Consolidation
  - Current situation:
    - General government deficit nearly 10 percent of GDP.
    - General government debt almost 65 percent of GDP.
    - Consolidation since 1991 crisis has been erased.
  - Consequences:
    - Unsustainable deficit risks disorderly stop with serious growth consequences.
    - Borrowing at current levels crowds out private investment and imposes a heavy interest burden, diverting resources from development needs.
  - Recommended actions:
    - Passage and implementation of the Fiscal Responsibility and Budget Management Bill (seeks to eliminate the revenue deficit over the medium term) is welcome but insufficient alone.
    - Harder budget constraints at the state government level.
    - Tax reform.
    - Reductions in subsidies.
    - More rapid progress with privatization.
    - Focus on overall deficit rather than adherence to the golden rule of balancing current expenditures.
  - Urgency: gradual improvement plans in the 1990s failed; a more determined rate of deficit reduction is economically and politically preferable.

### Conclusion
- The reform agenda is formidable, politically and technically challenging; many reforms will confront privileged interests and entail painful adjustments.
- Long-term benefits far outweigh short-term costs; delay raises costs.
- If India implements these measures and increases growth to the 8-9 percent range, it can move out of the third world and inspire other countries.
- Closing exhortation to policymakers: "Just do it."

*Source: Breaking Out of the Third World: India's Economic Imperative — Address by Stanley Fischer, Special Advisor to the Managing Director, International Monetary Fund; as prepared for delivery, January 22, 2002.*

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## References

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